South Africa: Corporate Reorganisations: The Dividend Stripping Pitfall

Last Updated: 23 August 2018
Article by Nicolette Smit and Stephan Minne

Most Read Contributor in South Africa, September 2018

Under South African corporate reorganisation rules, tax consequences are deferred and do not crystalise at the time of the transaction, but a carefully planned restructuring transaction may result in hardship due to subsequent events. A recently proposed amendment illustrates this risk.

Tax relief under the existing corporate reorganisation rules may be neutralised if assets acquired in terms of these rules are disposed of within 18 months.

However, the consequences of a sale of capital assets within that period are often not severe. Other than disposals that result in an equity holding below certain key levels (such as de-grouping) and in the absence of tax losses, the normal tax treatment generally applies to gains or losses on such a disposal, based on the cost that was rolled-over in terms of the corporate rules. The distinguishing feature of a disposal within 18 months, is usually that any capital gain or loss that would have arisen had the asset not been acquired under the corporate rules, is ring-fenced.

The Draft Taxation Laws Amendment Bill, 2018 was recently released for public comment. It proposes amendments to the so-called dividend stripping rules contained in, inter alia, paragraph 43A of the Eighth Schedule to the Income Tax Act, 1962. In this context, a sale of shares held on capital account within 18 months of acquiring such shares under the corporate rules, may have far-reaching consequences.

Essentially, these provisions recharacterise certain dividends as income or proceeds from the sale of shares. Currently, where a share is sold and the shareholder earned extraordinary dividends (as defined) on that share, the dividends are treated as part of the sale proceeds if they are causally linked to the sale or were received or accrued within 18 months prior to the sale. Exempt dividends are extraordinary to the extent that, in aggregate, they exceed 15% of the market value of an ordinary share, based on the value when the share is sold or at the beginning of the 18-month period, if higher. A separate formula applies to preference shares. The proposal clarifies that this formula is based on the consideration for which the preference share is issued.

As mentioned, the proposed amendment applies to shares that were acquired in terms of the corporate rules (referred to as a deferral transaction). The proposal increases the pool of exempt dividends that may be recharacterised (to the extent that they cumulatively exceed the 15% threshold) in three ways:

  • dividends that fall into the pool are now measured over potentially a longer period;
  • dividends derived by persons other than the selling shareholder may be included in the pool; and
  • dividends from shares other than the share that is sold may also be included.

"Dividend stripping" period

Currently, the pool of dividends is determined by amounts distributed during the 18-month period prior to a sale. If a deferral transaction occurred during that period, certain dividends declared on relevant shares during the period of 18 months preceding the deferral transaction will also be included.

Relevant shares and shareholders

The existing dividend-stripping provisions arguably also apply to disposals of shares under the corporate rules. In terms of the proposal, only an external sale (other than under the corporate rules) will trigger the treatment of dividends as sale proceeds. However, there are new measures that govern the interaction with a deferral transaction.

Where an external sale takes place within 18 months of a deferral transaction, it is not only exempt dividends earned by the seller on the shares that are sold (sale shares) that will form part of the pool of dividends that must be assessed to determine whether the proceeds on disposal of the sale shares will be increased. It is proposed that certain exempt dividends on the following shares or earned by the following persons must also be included:

  • shares previously held by the seller (old shares) that were disposed of under a deferral transaction under which the old shares were exchanged for the sale shares or the sale shares were acquired by virtue of holding the old shares. Dividends derived by the seller from the old shares within 18 months prior to the deferral transaction are part of the pool.
  • dividends on the sale shares that were earned within 18 months before the deferral transaction by another person who disposed of the shares under a deferral transaction and was connected to the seller at any stage during the preceding 18 months. This could apply to dividends earned by more than one previous owner of the shares where more than one deferral transaction occurred within the 18-month period.

Example: shares acquired by exchange

Consider a group comprising company A with a wholly owned subsidiary B. The only asset of B is a minority equity interest in C. A acquires the shares in C (new shares) from B as a liquidation dividend. This is done under the corporate rules, ie, a deferral transaction. A thus acquires the C shares (new shares) by virtue of holding the B shares (old shares). Within 18 months, A sells the new shares to a third party.

The relevant pool of exempt dividends will be:

  • own dividend income (new shares)

    • dividends distributed to A on the shares in C during the period that A holds the shares (which is less than 18 months).
  • own dividend income (old shares)

    • dividends (except a dividend comprising the new shares) distributed to A on the shares in B within 18 months prior to the deferral transaction.
  • connected person dividend income (new shares)

    • dividends distributed by C to B during the 18-month period prior to the deferral transaction. (B is connected to A and disposed of the shares in C under a deferral transaction.)

Extraordinary dividend: new rule

Currently, the 15% rule mentioned above must be used to determine the extent to which dividends are extraordinary.

The Taxation Laws Amendment Bill, 2018 proposes a more onerous method that applies to shares (new shares) that are acquired under a deferral transaction through exchange for or by virtue of the holding of other shares (old shares) that are disposed under that transaction. The new method must be used if the taxpayer received an exempt dividend:

  • in respect of the old shares within 18 months before the deferral transaction; or
  • in respect of the new shares and the dividend was derived from a dividend on the old shares that was distributed within 18 months after the deferral transaction to the person who acquired the old shares.

The extraordinary dividend on such a transaction will be the higher of:

  • the amount determined by applying the existing 15% rule to the expanded pool of exempt dividends described above; and
  • the extraordinary dividend that would have resulted from a hypothetical sale of the old shares to a third party at market value at the time of the deferral transaction.

The effect is that notwithstanding that a company that is sold may be a high value company that allows dividends extracted to remain within the 15% level, a reorganisation transaction within the prior 18 months may still result in an extraordinary dividend which will increase the proceeds upon an external sale of the shares for capital gains tax purposes.

The proposals apply to sales of ordinary shares from 1 January 2019.

Conclusion

If the proposals are enacted, a sale of shares within 18 months after acquiring such shares under the corporate rules could have far-reaching consequences for the seller.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Pieter van der Zwan & Associates
Pieter van der Zwan & Associates
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Pieter van der Zwan & Associates
Pieter van der Zwan & Associates
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions